The XAU/USD reversal could be premature. Eyes on the Fed, GDP and PCE

Gold Fundamental Forecast – Bearish

  • The price of gold only gained one percent, but it was the best week since mid-June
  • Markets are increasingly pricing in a Fed pivot despite 9.1% YoY inflation
  • All eyes are on the Federal Reserve, US GDP and PCE data in the week ahead

Gold prices saw a slight recovery last week as XAU/USD rose around 1%. Although it wasn’t much, it was the best weekly performance since mid-June. The combination of a weaker US dollar and lower Treasury yields likely benefited the anti-fiat yellow metal. Is there more room here for gold to continue to rally?

To better understand the reversal in gold, you need to study what the markets expect from the Federal Reserve. All eyes are on its next interest rate announcement on Wednesday, where another 75 basis point rate hike is on the cards. This follows continued high US inflation, with an overall rate of 9.1% year-on-year and consistently beating economists’ estimates.

Still, a more hawkish Fed should boost the US dollar and bond yields, at the expense of gold. This has been the larger story this year, hence the persistent decline in XAU/USD. The global monetary tightening is also playing against gold. But, it seems that over the past week, the markets have become more focused on what might happen later.

Expectations of a Fed pivot next year have risen with markets seeing 2 cuts in 2023. This has been associated with deeper inversion of the yield curve, in particular the 10-year and 2-year yield spread. Meanwhile, economists have revised down real growth expectations for 2023. Despite this, short-term equilibrium rates have risen recently, indicating a rise in inflation expectations.

All this seems to paint a story of the markets seeing the Fed perhaps favoring the revival of economic growth despite inflation still at its highest level in 40 years. Could the markets get ahead? Well, we might have a better idea this week with the Fed. If the central bank continues to fight inflation firmly, it looks like we could be setting ourselves up for disappointment.

In such an outcome, the US dollar could rebound alongside Treasury yields. This would not bode well for the yellow metal. Outside of the central bank, the first estimate of second-quarter US GDP data is also expected. Growth of 0.4% q/q was observed, versus -1.6% in Q1. However, a negative drawdown would mean 2 consecutive GDP contractions. This is a commonly cited criterion for the technical definition of a recession.

Next, the week will end with the PCE data, which is the Fed’s favorite inflation indicator. Another strong impression could keep the central bank on its toes. As such, it may be too early to announce a rally in gold. I would go further to say that risks appear to be biased to the downside in the week ahead. As such, this is a bearish fundamental call.

Core Gold Drivers

Chart created in TradingView

— Written by Daniel Dubrovsky, Strategist for DailyFX.com

To contact Daniel, use the comments section below or @ddubrovskyFX on Twitter

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